USA – Michigan Court finds certain cloud computing services not subject to sales and use tax

The Michigan Court of Claims recently held in a summary disposition that remotely accessed software is not subject to Michigan sales and use tax. The court held that software accessed remotely was neither tangible personal property nor ‘used’ by the taxpayer as defined under Michigan statutes. Further, any prewritten computer software provided to the customer was only an incidental component of the various services purchased and did not subject the charges to tax. [Auto-Owners Insurance Company v. Department of Treasury, State of Michigan Court of Claims, No. 12-000082-MT (March 20, 2014)]

In detail

Auto-Owners Insurance Co. (Auto-Owners), headquartered in Michigan, frequently engages in third-party computing arrangements to accomplish tasks necessary to support its clients and independent agents. Under these arrangements, the company remotely accesses a third-party’s technology infrastructure, including its services as well as its networks, servers, data storage, and software applications not physically located on the user’s computer. The access permits users to accomplish tasks including the retrieval of data, the processing of billing and payments, and the acquisition of information such as data reports, risk analyses, property valuations, and legal research.

Michigan use tax

Michigan’s use tax is levied “for the privilege of using, storing, or consuming tangible personal property in this state.” The Court of Claims determined that the transactions at issue must, therefore, involve ‘tangible personal property’ that was ‘used’ in Michigan. Additionally, if such ‘tangible personal property’ is merely ‘incidental’ to services purchased in the same transaction, then the property is not subject to use tax.

Remotely accessed software is not tangible personal property

According to Michigan statutes, tangible personal property includes prewritten computer software. For computer software to constitute tangible personal property it must be ‘delivered by any means.’ The court concluded that remotely accessed software is not ‘delivered’ under the common meaning of the word because there was not surrender of possession and control of the software. What was transferred was information and data – not the software. Therefore, without being ‘delivered,’ the remotely accessed software it is not considered taxable tangible personal property.

Remotely accessed software was not ‘used’ in Michigan

Even though the court determined prewritten computer software was not delivered to Auto-Owners, it considered the second issue whether Auto-Owners used prewritten computer software within the meaning of the Use Tax Act. For use tax purposes, ‘use’ is defined as “the exercise of a right or power over tangible personal property incident to the ownership of that property….” The court acknowledged that mere ‘access’ does not equate to taxable ‘use.’ The court determined there was no evidence Auto-Owners exercised a right or power incident to ownership in the underlying software. Auto-Owners had no control over the underlying software used by the third-party provider to complete the necessary tasks. Therefore, the software was not ‘used’ for use tax purposes.

Use of the software was merely incidental to services

Finally, to complete its analysis the court reasoned that even if remotely accessed software was considered tangible personal property and was actually used within the state, it would still not be subject to tax if the software was deemed incidental to the services provided. To determine taxability, the court looked at the ‘incidental to service test’ outlined by the Michigan Supreme Court in Catalina Mktg Sales. Under this test, the court reviewed several factors to determine whether the transaction was principally a transfer of tangible personal property or a provision of a service.

The court concluded that since the third-party providers were not in the business of selling software, the software held no value without the associated services. Auto-Owners sought out services (data reports, risk analyses, property valuations, legal research, etc.) – not software. Accordingly, the remotely accessed software was merely incidental to the desired services and – even if considered to be tangible property used in Michigan – not subject to use tax.

The takeaway

Michigan has provided minimal public guidance in the past regarding the taxability of cloud computing and remotely accessed software. Nonetheless, many taxpayers currently treat such offerings as taxable within the state. In Auto- Owners, the Michigan Court of Claims clearly concluded that remotely accessed software is not subject to tax in Michigan.

In other current litigation, the Michigan Court of Claims decided against a taxpayer (Thomson Reuters) on the same issue. On appeal, however, the Court of Appeals recently heard oral arguments and the taxpayer cited the Auto-Owners decision as persuasive authority. The Auto-Owners decision, in concert with a positive outcome for Thomson Reuters at the appellate level, would create strong authority that cloud computing transactions are not subject to Michigan sales and use tax.

Companies purchasing or selling cloud computing services in Michigan should review whether such transactions are currently being taxed. Businesses should consider whether to file protective refund claims now in anticipation of a final determination by the Court of Appeals or state legislature that these services are not taxable.

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About Jennifer Jensen

email: jennifer.jensen@us.pwc.com Mobile: +1 240 678 0226 Office: +1 202 414 1741

Jennifer is a state and local tax director in PwC Washington National Tax Services specializing in sales and use and indirect taxes. Her industry focus is in technology, entertainment, media, and communications. Jennifer helps lead the firm’s cloud computing initiative and is the state and local subject matter expert in this area. Jennifer provides both internal firm and external client sales and use tax training in such issues as eCommerce, the taxation of digital products, and, of course, cloud computing. She also summarizes relevant legislation or other tax law changes to disseminate both externally and internally and writes thought leadership pieces for external publication by the firm.